Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 
FORM 10-Q 

(Mark One)
 
[ X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2018  
or
 
[  ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________________________ to _________________________________
 
Commission File Number:  0-17196
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12523595&doc=12 
MGP INGREDIENTS, INC.
(Exact name of registrant as specified in its charter) 

KANSAS
45-4082531
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
 
 
100 Commercial Street, Atchison, Kansas
66002
(Address of principal executive offices)
(Zip Code)
 
(913) 367-1480
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  [X] Yes [  ] No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). [X ] Yes [  ] No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an "emerging growth company."  See definition of "large accelerated filer", "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
[  ] Large accelerated filer                                                         [X] Accelerated filer
[  ]  Non-accelerated filer (Do not check if smaller reporting company   [ ] Smaller Reporting Company
[ ] Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). [ ]Yes [X] No
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. 

16,856,414 shares of Common Stock, no par value as of October 26, 2018



INDEX
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

METHOD OF PRESENTATION

Throughout this Report, when we refer to "the Company," "MGP," "we," "us," "our," and words of similar import, we are referring to the combined business of MGP Ingredients, Inc. and its consolidated subsidiaries, except to the extent that the context otherwise indicates. In this document, for any references to Note 1 through Note 10, refer to the Notes to Unaudited Condensed Consolidated Financial Statements in Item 1.
 
All amounts in this report, except for share, par values, bushels, gallons, pounds, mmbtu, proof gallons, per share, per bushel, per gallon, per proof gallon and percentage amounts, are shown in thousands unless otherwise noted.


2


PART I. FINANCIAL INFORMATION 

ITEM 1. FINANCIAL STATEMENTS

MGP INGREDIENTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(Dollars in thousands, except per share amounts)
 
 
Quarter Ended
 
Year to Date Ended
 
 
September 30,
2018
 
September 30,
2017
 
September 30,
2018
 
September 30,
2017
Net sales
 
$
95,031

 
$
86,333

 
$
271,239

 
$
259,255

Cost of sales (a)
 
75,432

 
67,708

 
213,248

 
202,764

Gross profit
 
19,599

 
18,625

 
57,991

 
56,491

Selling, general and administrative expenses
 
7,584

 
8,154

 
24,455

 
24,114

Operating income
 
12,015

 
10,471

 
33,536

 
32,377

Gain on sale of equity method investment (Note 3)
 

 
11,381

 

 
11,381

Equity method investment loss (Note 3)
 

 

 

 
(348
)
Interest expense, net
 
(334
)
 
(224
)
 
(830
)
 
(934
)
Income before income taxes
 
11,681

 
21,628

 
32,706

 
42,476

Income tax expense (Note 5)
 
2,673

 
7,491

 
7,244

 
13,292

Net income
 
$
9,008

 
$
14,137

 
$
25,462

 
$
29,184

 
 
 
 
 
 
 
 
 
Income attributable to participating securities
 
174

 
414

 
491

 
806

Net income attributable to common shareholders and used in earnings per share calculation (Note 6)
 
$
8,834

 
$
13,723

 
$
24,971

 
$
28,378

 
 
 
 
 
 
 
 
 
Share information:
 
 
 
 
 
 
 
 
Basic and Diluted weighted average common shares
 
16,872,091

 
16,751,346

 
16,861,700

 
16,735,378

 
 
 
 
 
 
 
 
 
Basic and diluted earnings per common share
 
$
0.52

 
$
0.82

 
$
1.48

 
$
1.70

Dividends and dividend equivalents per common share
 
$
0.08

 
$
0.89

 
$
0.24

 
$
0.97

 

(a)
Includes related party purchases of $0 and $18,425 for year to date September 30, 2018 and 2017, respectively. There were no related party purchases for the quarters ended September 30, 2018 and 2017.

















See accompanying notes to unaudited condensed consolidated financial statements

3



MGP INGREDIENTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Dollars in thousands)

 
Quarter Ended
 
Year to Date Ended
 
September 30,
2018
 
September 30,
2017
 
September 30,
2018
 
September 30,
2017
Net income
$
9,008

 
$
14,137

 
$
25,462

 
$
29,184

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Change in post-employment benefits
14

 
(39
)
 
42

 
(120
)
Other comprehensive income (loss)
14

 
(39
)
 
42

 
(120
)
Comprehensive income
$
9,022

 
$
14,098

 
$
25,504

 
$
29,064











































See accompanying notes to unaudited condensed consolidated financial statements

4



       MGP INGREDIENTS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Dollars in thousands)
 
 
September 30,
2018
 
December 31,
2017
Current Assets
 
 
 
 
Cash and cash equivalents
 
$

 
$
3,084

Receivables (less allowance for doubtful accounts: September 30, 2018 and December 31, 2017 - $24)
 
49,991

 
34,347

Inventory
 
107,346

 
93,149

Prepaid expenses
 
1,885

 
2,182

Refundable income taxes
 
2,011

 
1,980

Total current assets
 
161,233

 
134,742

 
 
 
 
 
Property and equipment
 
282,271

 
267,288

Less accumulated depreciation and amortization
 
(172,344
)
 
(164,237
)
Property and equipment, net
 
109,927

 
103,051

Other assets
 
2,420

 
2,535

Total assets
 
$
273,580

 
$
240,328

 
 
 
 
 
Current Liabilities
 
 

 
 

Current maturities of long-term debt
 
$
382

 
$
372

Accounts payable
 
22,905

 
30,037

Accrued expenses
 
8,545

 
11,171

Total current liabilities
 
31,832

 
41,580

 
 
 
 
 
Long-term debt, less current maturities
 
21,133

 
21,407

Credit agreement - revolver
 
23,605

 
2,775

Deferred credits
 
1,687

 
2,151

Accrued retirement, health and life insurance benefits
 
2,913

 
3,133

Other noncurrent liabilities
 
1,112

 
540

Deferred income taxes
 
936

 
12

Total liabilities
 
83,218

 
71,598

 
 
 
 
 
Contingencies (Note 7)
 


 


Stockholders’ Equity
 
 

 
 

Capital stock
 
 

 
 

Preferred, 5% non-cumulative; $10 par value; authorized 1,000 shares; issued and outstanding 437 shares
 
4

 
4

Common stock
 
 

 
 

No par value; authorized 40,000,000 shares; issued 18,115,965 shares at September 30, 2018 and December 31, 2017, and 16,851,916 and 16,797,420 shares outstanding at September 30, 2018 and  December 31, 2017, respectively
 
6,715

 
6,715

Additional paid-in capital
 
14,888

 
13,912

Retained earnings
 
188,469

 
167,129

Accumulated other comprehensive loss
 
(269
)
 
(311
)
Treasury stock, at cost
 
 

 
 

Shares of 1,264,049 at September 30, 2018 and 1,318,545 at December 31, 2017
 
(19,445
)
 
(18,719
)
Total stockholders’ equity
 
190,362

 
168,730

Total liabilities and stockholders’ equity
 
$
273,580

 
$
240,328



See accompanying notes to unaudited condensed consolidated financial statements

5



MGP INGREDIENTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
 
 
Year to Date Ended
 
 
September 30,
2018
 
September 30,
2017
Cash Flows from Operating Activities
 
 
 
 
Net income
 
$
25,462

 
$
29,184

Adjustments to reconcile net income to net cash provided by operating activities:
 
 

 
 

Depreciation and amortization
 
8,529

 
8,441

Distributions received from equity method investee
 

 
7,131

Deferred income taxes
 
924

 
356

Share-based compensation
 
2,464

 
2,130

Gain on sale of equity method investment
 

 
(11,381
)
Equity method investment loss
 

 
348

Changes in operating assets and liabilities:
 
 

 
 

Receivables, net
 
(15,644
)
 
(11,366
)
Inventory
 
(14,197
)
 
(10,794
)
Prepaid expenses
 
297

 
(824
)
Accounts payable
 
(3,453
)
 
4,193

Accounts payable to affiliate, net
 

 
(3,349
)
Accrued expenses
 
(2,623
)
 
790

Income taxes payable/refundable
 
(31
)
 
2,472

Deferred credit
 
(464
)
 
(617
)
Accrued retirement health and life insurance benefits
 
395

 
(267
)
Net cash provided by operating activities
 
1,659

 
16,447

Cash Flows from Investing Activities
 
 

 
 

Additions to plant, property and equipment
 
(18,870
)
 
(13,630
)
Return of equity method investment
 

 
22,832

Proceeds from property insurance recoveries
 

 
14

Net cash provided by (used in) investing activities
 
(18,870
)
 
9,216

Cash Flows from Financing Activities
 
 

 
 

Purchase of treasury stock for tax withholding on equity-based compensation
 
(2,215
)
 
(1,377
)
Payment of dividends and dividend equivalents
 
(4,125
)
 
(16,692
)
Proceeds on long-term debt
 

 
20,000

Principal payments on long-term debt
 
(279
)
 
(268
)
Proceeds from credit agreement - revolver
 
22,766

 
20,580

Payments on credit agreement - revolver
 
(2,020
)
 
(41,985
)
Loan fees incurred with borrowings
 

 
(377
)
Net cash provided by (used in) financing activities
 
14,127

 
(20,119
)
Increase (decrease) in cash and cash equivalents
 
(3,084
)
 
5,544

Cash and cash equivalents, beginning of period
 
3,084

 
1,569

Cash and cash equivalents, end of period
 
$

 
$
7,113





See accompanying notes to unaudited condensed consolidated financial statements

6



MGP INGREDIENTS, INC.
CONDENSED CONSOLIDATED STATEMENT OF
CHANGES IN STOCKHOLDERS’ EQUITY
(Unaudited)
(Dollars in thousands)
 
 
 
Capital
Stock
Preferred
 
Common Stock
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Loss
 
Treasury
Stock
 
Total
Balance, December 31, 2017
 
$
4

 
$
6,715

 
$
13,912

 
$
167,129

 
$
(311
)
 
$
(18,719
)
 
$
168,730

Comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 

 

 

 
25,462

 

 

 
25,462

Other comprehensive income
 

 

 

 

 
42

 

 
42

Dividends and dividend equivalents, net of estimated forfeitures
 

 

 

 
(4,122
)
 

 

 
(4,122
)
Share-based compensation
 

 

 
2,049

 

 

 

 
2,049

Stock shares awarded, forfeited, or vested
 

 

 
(1,073
)
 

 

 
1,489

 
416

Purchase of treasury stock for tax withholding on equity-based compensation
 

 

 

 

 

 
(2,215
)
 
(2,215
)
Balance, September 30, 2018
 
$
4

 
$
6,715

 
$
14,888

 
$
188,469

 
$
(269
)
 
$
(19,445
)
 
$
190,362

 































See accompanying notes to unaudited condensed consolidated financial statements

7



MGP INGREDIENTS, INC.
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, unless otherwise noted)

Note 1.  Accounting Policies and Basis of Presentation

The Company. MGP Ingredients, Inc. ("Company") is a Kansas corporation headquartered in Atchison, Kansas and is a leading producer and supplier of premium distilled spirits and specialty wheat protein and starch food ingredients. Distilled spirits include premium bourbon and rye whiskeys and grain neutral spirits, including vodka and gin. MGP is also a top producer of high quality industrial alcohol for use in both food and non-food applications. The Company’s protein and starch food ingredients provide a host of functional, nutritional, and sensory benefits for a wide range of food products to serve the packaged goods industry. The Company's distillery products are derived from corn and other grains (including rye, barley, wheat, barley malt, and milo), and its ingredient products are derived from wheat flour.  The majority of the Company's sales are made directly or through distributors to manufacturers and processors of finished packaged goods or to bakeries.

Basis of Presentation and Principles of Consolidation. The unaudited condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. These unaudited condensed consolidated financial statements as of and for the quarter ended September 30, 2018 should be read in conjunction with the consolidated financial statements and notes thereto in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017 filed with the Securities and Exchange Commission ("SEC").  The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting of normal and recurring adjustments) necessary to fairly present the results for interim periods in accordance with United States ("U.S.") generally accepted accounting principles (“GAAP”).  Pursuant to the rules and regulations of the SEC, certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted.

Use of Estimates.  The financial reporting policies of the Company conform to GAAP.  The preparation of unaudited condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period.  The application of certain of these policies places demands on management’s judgment, with financial reporting results relying on estimation about the effects of matters that are inherently uncertain.  For all of these policies, management cautions that future events rarely develop as forecast, and estimates routinely require adjustment and may require material adjustment.

Inventory.  Inventory includes finished goods, raw materials in the form of agricultural commodities used in the production process and certain maintenance and repair items.  Bourbon and whiskeys are normally aged in barrels for several years, following industry practice; all barreled bourbon and whiskey is classified as a current asset. The Company includes warehousing, insurance, and other carrying charges applicable to barreled whiskey in inventory costs.

Inventories are stated at lower of cost or net realizable value on the first-in, first-out, or FIFO, method.  Inventory valuations are impacted by constantly changing prices paid for key materials, primarily corn. Inventory consists of the following:
 
 
September 30,
2018
 
December 31,
2017
Finished goods
 
$
19,924

 
$
13,284

Barreled distillate (bourbon and whiskey)
 
71,531

 
65,726

Raw materials
 
5,109

 
3,954

Work in process
 
1,551

 
1,935

Maintenance materials
 
7,555

 
7,256

Other
 
1,676

 
994

Total
 
$
107,346

 
$
93,149



8



Revenue Recognition. As a result of the adoption of Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers and related amendments ("Topic 606") on January 1, 2018, the Company has changed its accounting policy for revenue recognition (see Note 2). Revenue is recognized when control of the promised goods or services, through performance obligations by the Company, is transferred to the customer in an amount that reflects the consideration it expects to be entitled to in exchange for the performance obligations. The term between invoicing and when payment is due is not significant and the period between when the entity transfers the promised good or service to the customer and when the customer pays for that good or service is one year or less.

Excise taxes that are both imposed on and concurrent with a specific revenue-producing transaction, that are collected by the Company from a customer are excluded from revenue. Revenue is recognized for the sale of products at the point in time finished products are delivered to the customer in accordance with shipping terms. This is a faithful depiction of the satisfaction of the performance obligation because, at that point control passes to the customer, the customer has legal title and the risk and rewards of ownership have transferred, and the customer has present obligation to pay.

The Company’s distillery products segment routinely enters into bill and hold arrangements, whereby the Company produces and sells unaged distillate to customers, and the product is subsequently barreled at the customer’s request and warehoused at a Company location for an extended period of time in accordance with directions received from the Company’s customers. Even though the unaged distillate remains in the Company's possession, a sale is recognized at the point in time when the customer obtains control of the product. Control is transferred to the customer in bill and hold transactions when: customer acceptance specifications have been met, legal title has transferred, the customer has a present obligation to pay for the product, the risk and rewards of ownership have transferred to the customer, and all the following additional bill and hold criteria have been met: the customer has requested the product be warehoused, the product has been identified as separately belonging to the customer, the product is currently ready for physical transfer to the customer, and the Company does not have the ability to use the product or direct it to another customer.

Warehouse service revenue is recognized over the time that warehouse services are rendered and as they are rendered. This is a faithful depiction of the satisfaction of the performance obligation because control of the aging products has already passed to the customer and there are no additional performance activities required by the Company, except as requested by the customer. The performance of the service activities, as requested, is invoiced as satisfied and revenue is concurrently recognized.

Income Taxes. The Company accounts for income taxes using an asset and liability method which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis.

Earnings Per Share ("EPS").  Basic and diluted EPS are computed using the two-class method, which is an earnings allocation formula that determines net income per share for each class of Common Stock and participating security according to dividends declared and participation rights in undistributed earnings.  Per share amounts are computed by dividing net income attributable to common shareholders by the weighted average shares outstanding during the period.

Fair Value of Financial Instruments.  The Company determines the fair values of its financial instruments based on a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The hierarchy is broken down into three levels based upon the observability of inputs. Fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Level 2 inputs include quoted prices for similar assets and liabilities in active markets and inputs other than quoted prices that are observable for the asset or liability. Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value in its entirety requires judgment and considers factors specific to the asset or liability.
 
The Company’s short term financial instruments include cash and cash equivalents, accounts receivable and accounts payable.  The carrying value of the short term financial instruments approximates the fair value due to their short term nature. These financial instruments have no stated maturities or the financial instruments have short term maturities that approximate market.
 

9



The fair value of the Company’s debt is estimated based on current market interest rates for debt with similar maturities and credit quality. The fair value of the Company’s debt was $45,045 and $24,838 at September 30, 2018 and December 31, 2017, respectively. The financial statement carrying value of total debt was $45,120 (including unamortized loan fees) and $24,554 (including unamortized loan fees) at September 30, 2018 and December 31, 2017, respectively.  These fair values are considered Level 2 under the fair value hierarchy.

Recently Issued Accounting Pronouncements. In July 2018, the Financial Accounting Standards Board ("FASB") issued ASU 2018-09, Codification Improvements, which clarifies and corrects unintended application of guidance, and makes improvements to several Codification Topics. Most of the amendments are effective immediately. Some of the amendments are effective for Public business entities for annual and interim periods in fiscal years beginning after December 15, 2018, and for all other entities, for annual periods in fiscal years beginning after December 15, 2019, and interim periods in fiscal years beginning after December 15, 2020. Other amendments, which affect recently issued ASUs that are not yet effective, are effective with the original ASU. The Company is evaluating the effect that ASU 2018-09 will have on its consolidated financial statements and related disclosures.

In July 2018, the FASB issued ASU 2018-10, Codification Improvements to Topic 842, Leases, which clarifies and corrects errors in ASC 842. The effective date and transition requirements in ASU 2018-10 are the same as the effective date and transition requirements of ASU 2016-02. The Company is evaluating the effect that ASU 2018-10 will have on its consolidated financial statements and related disclosures in conjunction with ASU 2016-02.

In July 2018, the FASB issued ASU 2018-11, Leases (Topic 842): Targeted Improvements, which creates a new, optional transition method for implementing ASU 2016-02 and a lessor practical expedient for separating lease and non-lease components. This ASU is effective for entities that have not early adopted ASU 2016-02, with the effective date of ASU 2016-02. It is effective for entities that have early adopted ASU 2016-02, upon issuance. However, it can only be adopted by entities either at (1) the beginning of the company’s first reporting period after issuance or (2) the entity’s mandatory ASC 842 effective date. The Company is evaluating the effect that ASU 2018-11 will have on its consolidated financial statements and related disclosures in conjunction with ASU 2016-02.

In February 2018, the FASB issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. This ASU is effective for all entities for annual and interim periods in fiscal years beginning after December 15, 2018. Early adoption is permitted, including adoption in any interim period, (1) for public business entities for reporting periods for which financial statements have not yet been issued and (2) for all other entities for reporting periods for which financial statements have not yet been made available for issuance. The Company is evaluating the effect that ASU 2018-02 will have on its consolidated financial statements and related disclosures.

In January 2018, the FASB issued ASU 2018-01, Land Easement Practical Expedient for Transition to Topic 842, which clarifies that land easements are in the scope of ASU 2016-02, Leases, and provides transition relief. The effective date and transition requirements of ASU 2018-01 are the same as the effective date and transition requirements of ASU 2016-02 (see below). The Company expects to elect this practical expedient and not evaluate under Topic 842 existing or expired land easements.

In February 2016, the FASB issued ASU 2016-02, Leases, which aims to make leasing activities more transparent and comparable and requires substantially all leases be recognized by lessees on their balance sheet as a liability for lease payments and a right-of-use asset for its right to use the underlying asset during the lease term. This ASU is effective for public business entities for interim and annual reporting periods beginning after December 15, 2018. Although early adoption is permitted, the Company is not planning to early adopt the new standard, which replaces existing lease accounting guidance.  The Company can elect to adopt ASC 2016-02 using a modified retrospective transition method requiring application for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. Alternatively, the Company can and has chosen to use its effective date as the date of initial application. The Company expects to elect all of the new standard's available transition practical expedients. This ASU will have no impact on the covenants of the Company's Credit Agreements, as changes in leasing standards are excluded from covenant calculations for the Credit Agreements. While the Company has not yet reached a conclusion on the overall impacts of adopting ASU 2016-02, management has identified its rail car lease obligations as being the primary operating lease pool impacted. As of December 31, 2017, the Company had operating leases for 223 rail cars.

10




Recently Adopted Accounting Standard Updates. In March 2017, the FASB issued ASU 2017-07, Compensation-Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, which requires companies to present the service cost component of net benefit cost in the same line items in which they report compensation cost. Companies will present all other components of net benefit cost outside operating income, if this subtotal is presented. This ASU was effective for public business entities for annual and interim periods in fiscal years beginning after December 15, 2017. The Company adopted ASU 2017-07 on January 1, 2018, with an immaterial impact on its financial results and presentation for the quarter and year to date ended September 30, 2018.

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which requires companies to include cash and cash equivalents that have restrictions on withdrawal or use in total cash and cash equivalents on the statement of cash flows. This ASU is effective for public business entities for annual and interim periods in fiscal years beginning after December 15, 2017. The Company adopted ASU 2016-18 on January 1, 2018, and has determined that there was no impact to the presentation of the unaudited condensed consolidated statements of cash flows because the Company had no restricted cash for the quarter and year to date ended September 30, 2018 and 2017.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which addresses eight classification issues related to the statement of cash flows: Debt prepayment or debt extinguishment costs; Settlement of zero coupon bonds; Contingent consideration payments made after a business combination; Proceeds from the settlement of insurance claims; Proceeds from the settlement of corporate owned life insurance policies, including bank owned life insurance policies; Distributions received from equity method investees; Beneficial interests in securitization transactions; and Separately identifiable cash flows and application of the predominance principle. This ASU was effective for public business entities for annual and interim periods in fiscal years beginning after December 15, 2017. The Company adopted ASU 2016-15 on January 1, 2018, and has determined that there was no impact to the presentation of the unaudited condensed consolidated statements of cash flows for the quarter and year to date ended September 30, 2018 and 2017.
    
Note 2.  Revenue

Adoption of Topic 606, Revenue from Contracts with Customers

On January 1, 2018, the Company adopted Topic 606, using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018. Financial results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts are not adjusted and continue to be reported in accordance with the Company's historic accounting under Accounting Standards Codification 605, Revenue Recognition ("ASC 605"). The Company has completed its evaluation of the impact of Topic 606 and concluded that there is no impact to the financial statements as a result of its adoption. The Company recorded no adjustment to opening retained earnings as of January 1, 2018 related to the transition from ASC 605 to Topic 606 and there are no differences to disclose to reconcile financial statement activity as reported under Topic 606 to ASC 605 for the quarter and year to date ended September 30, 2018.


11



Disaggregation of Revenue.

The following table presents the Company's revenues disaggregated by segment and major products and services.
 
NET SALES
 
NET SALES
 
 
Quarter Ended September 30,
 
Year to Date Ended September 30,
 
 
2018
 
2017(a)
 
2018
 
2017(a)
 
Distillery Products
 
 
 
 
 
 
 
 
Premium beverage alcohol
$
46,864

 
$
43,941

 
$
133,135

 
$
131,868

 
Industrial alcohol
20,661

 
19,310

 
59,300

 
57,775

 
Food grade alcohol
67,525

 
63,251

 
192,435

 
189,643

 
Fuel grade alcohol
1,576

 
1,458

 
5,006

 
4,867

 
Distillers feed and related co-products
5,898

 
4,860

 
18,785

 
14,514

 
Warehouse services
3,337

 
2,766

 
9,139

 
7,960

 
Total distillery products
$
78,336

 
$
72,335

 
$
225,365

 
$
216,984

 
 
 
 
 
 
 
 
 
 
Ingredient Solutions
 
 
 
 
 
 
 
 
Specialty wheat starches
$
7,030

 
$
7,008

 
$
21,170

 
$
20,826

 
Specialty wheat proteins
5,486

 
4,939

 
16,230

 
14,541

 
Commodity wheat starch
2,793

 
1,948

 
6,926

 
6,302

 
Commodity wheat protein
1,386

 
103

 
1,548

 
602

 
Total ingredient solutions
$
16,695

 
$
13,998

 
$
45,874

 
$
42,271

 
 
 
 
 
 
 
 
 
 
Total net sales
$
95,031

 
$
86,333

 
$
271,239

 
$
259,255

 

(a) Prior period amounts were not adjusted upon adoption of Topic 606.

The following table presents the Company's revenues disaggregated by segment and timing of revenue recognition.
 
NET SALES
 
NET SALES
 
 
Quarter Ended September 30,
 
Year to Date Ended September 30,
 
 
2018
 
2017(a)
 
2018
 
2017(a)
 
Distillery Products
 
 
 
 
 
 
 
 
Products transferred at a point in time
$
74,999

 
$
69,569

 
$
216,226

 
$
209,024

 
Services transferred over time
3,337

 
2,766

 
9,139

 
7,960

 
Total distillery products
$
78,336

 
$
72,335

 
$
225,365

 
$
216,984

 
 
 
 
 
 
 
 
 
 
Ingredient Solutions
 
 
 
 
 
 
 
 
Products transferred at a point in time
$
16,695

 
$
13,998

 
$
45,874

 
$
42,271

 
 
 
 
 
 
 
 
 
 
Total net sales
$
95,031

 
$
86,333

 
$
271,239

 
$
259,255

 

(a) Prior period amounts were not adjusted upon adoption of Topic 606.

The Company generates revenues from the distillery products segment by the sale of products and by providing warehouse services related to the storage and aging of customer products. The Company generates revenues from the ingredient solutions segment by the sale of products.


12



Contracts with customers in both segments include a single performance obligation (either the sale of products or the provision of warehouse services). Certain customers may receive volume rebates or discounts, which are accounted for as variable consideration. The Company estimates these amounts based on the expected amount to be provided to customers and reduces revenues recognized. The Company believes there will be no significant changes to the estimates of variable consideration.

Note 3.  Equity Method Investments

As of September 30, 2018, the Company had no investments accounted for using the equity method of accounting. Until July 3, 2017, the Company had a 30 percent interest in Illinois Corn Processing ("ICP"), which manufactured alcohol for fuel, industrial and beverage applications. The Company completed the sale of its equity ownership interest in ICP to Pacific Ethanol Central, LLC, on July 3, 2017, consistent with an Agreement and Plan of Merger entered into on June 26, 2017.

Summary Financial Information (unaudited). Condensed financial information related to the Company’s non-consolidated equity method investment in ICP for the quarter and year to date ended September 30, 2017 is shown below.
 
 
Quarter Ended September 30,
 
Year to Date Ended September 30,
 
 
2017
 
2017
ICP’s Operating results:
 
 
 
 
Net sales (a)
 
$

 
$
78,062

Cost of sales and expenses (b)
 

 
79,224

Net loss
 
$

 
$
(1,162
)

(a) 
Includes related party sales to MGPI for the quarter and year to date ended September 30, 2017 of $0 and $17,672, respectively.
(b) 
Includes depreciation and amortization for the quarter and year to date ended September 30, 2017of $0 and $1,720, respectively.

The Company’s equity method investment losses for the quarter and year to date ended September 30, 2017, based on unaudited financial statements, were $0 and $348, respectively. The Company also had a gain on sale of equity method investment for the quarter and year to date ended September 30, 2017 of $11,381, resulting from the July 3, 2017 sale of ICP.

Note 4.  Corporate Borrowings

Indebtedness Outstanding:
Description(a)
September 30,
2018
 
December 31,
2017
Credit Agreement - Revolver, 3.593% (variable rate) due 2022
$
24,044

 
$
3,298

Secured Promissory Note, 3.71% (variable rate) due 2022
1,688

 
1,966

Prudential Note Purchase Agreement, 3.53% (fixed rate) due 2027
20,000

 
20,000

Unamortized loan fees(b)
(612
)
 
(710
)
Total indebtedness outstanding
$
45,120

 
$
24,554

Less current maturities of long-term debt
(382
)
 
(372
)
Long-term debt
$
44,738

 
$
24,182


(a) Interest rates are as of September 30, 2018.
(b) Loan fees are being amortized over the life of the Credit Agreement and Note Purchase Agreement.

Credit and Note Purchase Agreements. On August 23, 2017, the Company entered into a credit agreement (the “Credit Agreement”) with Wells Fargo Bank, National Association. The Credit Agreement provides for a $150,000 revolving credit facility. The Company may increase the facility from time to time by an aggregate principal amount of up to $25,000 provided certain conditions are satisfied and at the discretion of the lender. The Credit Agreement matures on August 23, 2022. The Credit Agreement includes certain requirements and covenants, which the Company was in compliance with at September 30, 2018. As of September 30, 2018, the Company's total outstanding borrowings under the Credit Agreement were $24,044 leaving $125,956 available.
 

13



On August 23, 2017, the Company also entered into a Note Purchase and Private Shelf Agreement (the “Note Purchase Agreement”) with PGIM, Inc., an affiliate of Prudential Financial, Inc., and certain affiliates of PGIM, Inc. The Note Purchase Agreement provides for the issuance of up to $75,000 of Senior Secured Notes, and the Company issued $20,000 of Senior Secured Notes with a maturity date of August 23, 2027. The Note Purchase Agreement includes certain requirements and covenants, which the Company was in compliance with at September 30, 2018.

Note 5. Income Taxes
On December 22, 2017, the U.S. government enacted tax reform legislation commonly known as the Tax Cuts and Jobs Act (the “Tax Act”), resulting in significant modifications to U.S. tax law. In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”), which provides guidance on accounting for the tax effects of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete the accounting under ASC 740. As of September 30, 2018, the Company has not made a measurement period adjustment and the accounting for the Tax Act remains incomplete.

The Company's tax provision for interim periods is determined using an estimated annual effective tax rate, adjusted for discrete items arising in that quarter. In each quarter, the estimated annual effective tax rate is updated and a year-to-date adjustment is made to the provision. The Company's quarterly effective tax rate is subject to significant volatility due to the effect of discrete items arising in a given quarter. Income tax expense for the quarter and year to date ended September 30, 2018 was $2,673 and $7,244, respectively, for an effective tax rate for the quarter of 22.9 percent and for the year to date of 22.1 percent. For the quarter, the effective tax rate differed from the 21 percent federal statutory rate (as lowered by the Tax Act) on pretax income, primarily due to state taxes, including a reduction of state taxes for state income tax credits in Indiana and Kansas. Year to date, the effective tax rate differed from the 21 percent federal statutory rate (as lowered by the Tax Act) on pretax income, primarily due to state taxes, including a reduction of state taxes for state income tax credits in Indiana and Kansas, a change in estimate related to the sale of the Company's interest in ICP, and an increase in the Company’s valuation allowance related to capital loss carryforwards and state net operating losses. These amounts were partially offset by the impact of income tax benefits related to share-based compensation as accounted for in ASU 2016-09, Compensation - Stock Compensation (Topic 718) Improvements to Employee Share-Based Payment Accounting.

Income tax expense for the quarter and year to date ended September 30, 2017 was $7,491 and $13,292, respectively, for an effective tax rate for the quarter of 34.6 percent and for the year to date of 31.3 percent. The increase in tax expense, compared to prior quarters in 2017, largely relates to the Company’s sale of its interest in ICP, and the corresponding tax gain recognized in the annual effective tax rate calculation. The effective tax rate differed from the 35 percent federal statutory rate on pretax income, primarily due to the impact of income tax benefits related to share-based compensation as accounted for in ASU 2016-09, Compensation - Stock Compensation (Topic 718) Improvements to Employee Share-Based Payment Accounting, the domestic production activities deduction, state tax planning including state income tax credits in Indiana and Kansas, and changes to the Company's valuation allowance, partially offset by state taxes.


14



Note 6.  EPS

The computations of basic and diluted EPS for the quarters and year to date ended September 30, 2018 and 2017 are as follows:
 
 
Quarter Ended
 
Year to Date Ended
 
 
September 30,
2018
 
September 30,
2017
 
September 30,
2018
 
September 30,
2017
Operations:
 
 
 
 
 
 
 
 
Net income(a)
 
$
9,008

 
$
14,137

 
$
25,462

 
$
29,184

Income attributable to participating securities(b)
 
174

 
414

 
491

 
806

Net income attributable to common shareholders
 
$
8,834

 
$
13,723

 
$
24,971

 
$
28,378

 
 
 
 
 
 
 
 
 
Share information:
 
 
 
 
 
 
 
 
Basic and diluted weighted average common shares(c)
 
16,872,091

 
16,751,346

 
16,861,700

 
16,735,378

 
 
 
 
 
 
 
 
 
Basic and diluted EPS
 
$
0.52

 
$
0.82

 
$
1.48

 
$
1.70

 
 
 
 
 
 
 
 
 
(a) 
Net income attributable to all shareholders.
(b) 
Participating securities included 331,375 and 485,491 unvested restricted stock units ("RSUs"), at September 30, 2018 and 2017, respectively.
(c) 
Under the two-class method, basic and diluted weighted average common shares at September 30, 2018 and 2017, exclude unvested, participating securities.

Note 7.  Contingencies

There are various legal and regulatory proceedings involving the Company and its subsidiaries.  The Company accrues estimated costs for a contingency when management believes that a loss is probable and can be reasonably estimated.
 
A chemical release occurred at the Company's Atchison facility on October 21, 2016, which resulted in emissions venting into the air ("the Atchison Chemical Release").  The Company reported the event to the Environmental Protection Agency ("EPA"), the Occupational, Safety, and Health Administration ("OSHA"), and to Kansas and local authorities on that date, and is cooperating fully to investigate and ensure that all appropriate response actions are taken.  The Company has also engaged outside experts to assist the investigation and response.  The Company believes it is probable that a fine or penalty may be imposed by regulatory authorities, but it is currently unable to reasonably estimate the amount thereof since some investigations are not complete and could take several months up to a few years to complete.  Private plaintiffs have initiated, and additional private plaintiffs may initiate, legal proceedings for damages resulting from the emission, but the Company is currently unable to reasonably estimate the amount of any such damages that might result.  The Company's insurance is expected to provide coverage of any damages to private plaintiffs, subject to a deductible of $250, but certain regulatory fines or penalties may not be covered and there can be no assurance to the amount or timing of possible insurance recoveries if ultimately claimed by the Company.  There was no significant damage to the Company's Atchison plant as a result of this incident.  No other MGP facilities, including the distillery in Lawrenceburg, Indiana, were affected by this incident.

OSHA completed its investigation of the Atchison Chemical Release and, on April 19, 2017, issued its penalty to the Company in the amount of $138.  Management settled this assessment with OSHA in full for $75, which was paid on May 16, 2017. A portion, or all, of the penalty amount may be covered by insurance.

The EPA informed the Company on August 1, 2017, that it intends to seek civil penalties of approximately $250 in connection with its investigation of the Atchison Chemical Release, while offering the Company the opportunity to settle the matter prior to the EPA proceeding with a formal enforcement action. The Company is seeking a negotiated settlement with the EPA, but negotiations have paused pending resolution of the EPA's criminal investigation. Since the Company expects a negotiated resolution of the EPA civil case and EPA-proposed civil penalties are not material to the quarter and year to date ended September 30, 2018, the Company has not included an accrual in its results. A portion, or all, of the settled penalty amount may be covered by insurance.


15



Note 8.  Employee and Non-Employee Benefit Plans

Equity-Based Compensation Plans.  The Company’s equity-based compensation plans provide for the awarding of stock options, stock appreciation rights, shares of restricted stock ("Restricted Stock"), and RSUs for senior executives and salaried employees, as well as non-employee directors. The Company has two active equity-based compensation plans: the Employee Equity Incentive Plan of 2014 (the "2014 Plan") and the Non-Employee Director Equity Incentive Plan (the "Directors' Plan"). The 2014 Plan replaced the inactive Stock Incentive Plan of 2004.

As of September 30, 2018, 321,151 RSUs had been granted of the 1,500,000 shares approved under the 2014 Plan, and 68,934 shares had been granted of the 300,000 shares approved under the Directors' Plan. As of September 30, 2018, 334,225 unvested RSUs were outstanding under the Company’s long-term incentive plans.

Note 9.  Operating Segments

At September 30, 2018 and 2017, the Company had two segments: distillery products and ingredient solutions. The distillery products segment consists of food grade alcohol and distillery co-products, such as distillers feed (commonly called dried distillers grain in the industry) and fuel grade alcohol. The distillery products segment also includes warehouse services, including barrel put away, storage, retrieval, and blending services. Ingredient solutions consists of specialty starches and proteins and commodity starches and proteins.

Operating profit for each segment is based on net sales less identifiable operating expenses.  Non-direct SG&A, interest expense, earnings from the Company's equity method investments until sold on July 3, 2017, other special charges, and other general miscellaneous expenses are excluded from segment operations and are classified as Corporate.  Receivables, inventories, and equipment have been identified with the segments to which they relate.  All other assets are considered as Corporate.
 
 
Quarter Ended
 
Year to Date Ended
 
 
September 30,
2018
 
September 30,
2017
 
September 30,
2018
 
September 30,
2017
Net Sales to Customers
 
 
 
 
 
 
 
 
Distillery products
 
$
78,336

 
$
72,335

 
$
225,365

 
$
216,984

Ingredient solutions
 
16,695

 
13,998

 
45,874

 
42,271

Total
 
95,031

 
86,333

 
271,239

 
259,255

Gross Profit
 
 
 
 
 
 
 
 
Distillery products
 
16,269

 
16,501

 
48,819

 
49,069

Ingredient solutions
 
3,330

 
2,124

 
9,172

 
7,422

Total
 
19,599

 
18,625

 
57,991

 
56,491

Depreciation and Amortization
 
 
 
 
 


 
 
Distillery products
 
2,067

 
2,128

 
6,565

 
6,300

Ingredient solutions
 
369

 
419

 
1,182

 
1,242

Corporate
 
267

 
340

 
782

 
899

Total
 
2,703

 
2,887

 
8,529

 
8,441

Income (loss) before Income Taxes 
 
 
 
 
 
 
 
 
Distillery products
 
14,344

 
14,836

 
43,298

 
44,485

Ingredient solutions
 
2,671

 
1,518

 
7,236

 
5,592

Corporate
 
(5,334
)
 
5,274

 
(17,828
)
 
(7,601
)
Total
 
$
11,681

 
$
21,628

 
$
32,706

 
$
42,476


16




The following table allocates assets to each segment as of:
 
 
September 30, 2018
 
December 31, 2017
Identifiable Assets
 
 
 
 
Distillery products
 
$
219,587

 
$191,321
Ingredient solutions
 
38,139

 
28,950
Corporate
 
15,854

 
20,057
Total
 
$
273,580

 
$240,328

Note 10.  Subsequent Events

On October 30, 2018, the Board of Directors declared a quarterly dividend payable to stockholders of record as of November 15, 2018, of the Company's Common Stock, and a dividend equivalent payable to holders of certain RSUs as of November 15, 2018, of $.08 per share and per unit, payable on November 30, 2018.


17


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollar amounts in thousands, unless otherwise noted)

CAUTIONARY NOTE CONCERNING FACTORS THAT MAY AFFECT FUTURE RESULTS

This Report on Form 10-Q contains forward looking statements as well as historical information.  All statements, other than statements of historical facts, regarding the prospects of our industry and our prospects, plans, financial position, and strategic plan may constitute forward looking statements.  In addition, forward looking statements are usually identified by or are associated with such words as "intend," "plan," "believe," "estimate," "expect," "anticipate," "hopeful," "should," "may," "will," "could," "encouraged," "opportunities," "potential," and/or the negatives or variations of these terms or similar terminology.  Forward looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from those expressed or implied in the forward looking statements. A detailed discussion of risks and uncertainties that could cause actual results and events to differ materially from such forward looking statements is included in the section titled "Risk Factors" (Item 1A) of our Annual Report on Form 10-K for the year ended December 31, 2017. Forward looking statements are made as of the date of this report, and we undertake no obligation to update or revise publicly any forward looking statements, whether because of new information, future events or otherwise.

OVERVIEW

MGP is a leading producer and supplier of premium distilled spirits and specialty wheat protein and starch food ingredients. Distilled spirits include premium bourbon and rye whiskeys and grain neutral spirits ("GNS"), including vodka and gin. We are also a top producer of high quality industrial alcohol for use in both food and non-food applications. Our protein and starch food ingredients provide a host of functional, nutritional and sensory benefits for a wide range of food products to serve the packaged goods industry. We have two reportable segments: our distillery products segment and our ingredient solutions segment.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and accompanying notes included in this Form 10-Q, as well as our audited consolidated financial statements and accompanying notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations - General, set forth in our Annual Report on Form 10-K for the year ended December 31, 2017.


18



RESULTS OF OPERATIONS

Consolidated results

The table below details the consolidated results for quarters ended September 30, 2018 and 2017:
 
September 30,
 
 
 
2018
 
2017
 
2018 v. 2017
 
Net sales
$
95,031

 
$
86,333

 
10.1
 %
 
Cost of sales
75,432

 
67,708

 
11.4

 
Gross profit
19,599

 
18,625

 
5.2

 
   Gross margin %
20.6
%
 
21.6
%
 
(1.0
)
pp(a)
Selling, general, and administrative ("SG&A") expenses
7,584

 
8,154

 
(7.0
)
 
Operating income
12,015

 
10,471

 
14.7

 
   Operating margin %
12.6
%
 
12.1
%
 
0.5

pp
Gain on sale of equity method investment

 
11,381

 

 
Interest expense, net
(334
)
 
(224
)
 
49.1

 
Income before income taxes
11,681

 
21,628

 
(46.0
)
 
Income tax expense
2,673

 
7,491

 
(64.3
)
 
   Effective tax expense rate %
22.9
%
 
34.6
%
 
(11.7
)
pp
Net income
$
9,008

 
$
14,137

 
(36.3
)%
 
   Net income margin %
9.5
%
 
16.4
%
 
(6.9
)
pp

(a) Percentage points ("pp").

Net sales - Net sales for quarter ended September 30, 2018 were $95,031, an increase of 10.1 percent compared to the year-ago quarter, which was the result of increased net sales in both segments. Within the distillery segment, net sales were up 8.3 percent, primarily due to increases in the net sales of food grade alcohol, distillers feed and related co-products and warehouse services. Within the ingredient solutions segment, net sales were up 19.3 percent. Net sales were higher across all product categories, with the largest increases in commodity wheat proteins and starches and specialty wheat proteins (see Segment Results).

Gross profit - Gross profit for quarter ended September 30, 2018 was $19,599, an increase of 5.2 percent compared to the year-ago quarter. The increase was driven by an increase in gross profit in the ingredients solutions segment, partially offset by a decrease in gross profit in the distillery products segment. In the ingredient solutions segment, gross profit increased by $1,206, or 56.8 percent. In the distillery products segment, gross profit declined by $232, or 1.4 percent (see Segment Results).

SG&A expenses - SG&A expenses for quarter ended September 30, 2018 were $7,584, a decrease of 7.0 percent compared to the year-ago quarter. The decrease in SG&A was primarily due to lower personnel costs and a decrease in professional fees, partially offset by an investment in our brands platform.



19



Operating income - Operating income for quarter ended September 30, 2018 increased to $12,015 from $10,471 for quarter ended September 30, 2017, primarily due to an increase in gross profit in our ingredient solutions segment and a decrease in SG&A expenses described above, partially offset by a decrease in gross profit in our distillery products segment.
Operating income, quarter versus quarter
 
Operating Income
 
 Change
 
Operating income for quarter ended September 30, 2017
 
$
10,471

 
 
 
Increase in gross profit - ingredient solutions segment(a)
 
1,206

 
11.5

pp(b)
Decrease in gross profit - distillery products segment(a)
 
(232
)
 
(2.2
)
pp
Decrease in SG&A expenses
 
570

 
5.4

pp
Operating income for quarter ended September 30, 2018
 
$
12,015

 
14.7
 %
 

(a) See segment discussion.
(b) Percentage points ("pp").

Gain on equity method investment - We had no equity method investment earnings for quarters ended September 30, 2018 and 2017 due to the sale of our ICP equity method investment on July 3, 2017, which resulted in a gain on sale of equity method investment for the quarter ended September 30, 2017 of $11,381 (see Note 3).

Income tax expense - Income tax expense for quarter ended September 30, 2018 was $2,673, for an effective tax rate of 22.9 percent. Income tax expense for the quarter ended September 30, 2017 was $7,491, for an effective tax rate of 34.6 percent. The significant decrease in income tax expense, quarter versus quarter, was due to the tax impact of the previously-mentioned sale of ICP and the implementation of the Tax Cuts and Jobs Act (the "Tax Act"). The primary reason for the 11.7 percentage point decline in our effective tax rate, quarter versus quarter, is the decrease resulting from implementation of the Tax Act.

Earnings per share ("EPS") - EPS was $0.52 for quarter ended September 30, 2018 compared to $0.82 for quarter ended September 30, 2017. EPS decreased, quarter versus quarter, primarily due to the absence of a gain on sale of equity method investment in the current year quarter, partially offset by the decrease in our effective tax rate previously described and an increase in operating income.
Change in basic and diluted EPS, quarter versus quarter
 
Basic and Diluted EPS
 
Change
 
Basic and diluted EPS for quarter ended September 30, 2017
 
$
0.82

 
 
 
Increase in operations(a)
 
0.06

 
7.3

pp(b)
Decrease in gain on sale of equity method investment(a)
 
(0.44
)
 
(53.7
)
pp
Tax: Change in effective tax rate
 
0.07

 
8.6

pp
Decrease in income attributable to participating securities
 
0.01

 
1.2

pp
Basic and diluted EPS for quarter ended September 30, 2018
 
$
0.52

 
(36.6
)%
 

(a) 
Items are net of tax based on the effective tax rate for the base year (2017).
(b) 
Percentage points ("pp").











20



Consolidated results

The table below details the consolidated results for year to date ended September 30, 2018 and 2017:
 
September 30,
 
 
 
2018
 
2017
 
2018 v. 2017
 
Net sales
$
271,239

 
$
259,255

 
4.6
 %
 
Cost of sales
213,248

 
202,764

 
5.2

 
Gross profit
57,991

 
56,491

 
2.7

 
   Gross margin %
21.4
%
 
21.8
%
 
(0.4
)
pp(a)
SG&A expenses
24,455

 
24,114

 
1.4

 
Operating income
33,536

 
32,377

 
3.6

 
   Operating margin %
12.4
%
 
12.5
%
 
(0.1
)
pp
Gain on sale of equity method investment

 
11,381

 

 
Equity method investment loss

 
(348
)
 
(100.0
)
 
Interest expense, net
(830
)
 
(934
)
 
(11.1
)
 
Income before income taxes
32,706

 
42,476

 
(23.0
)
 
Income tax expense
7,244

 
13,292

 
(45.5
)
 
   Effective tax expense rate %
22.1
%
 
31.3
%
 
(9.2
)
pp
Net income
$
25,462

 
$
29,184

 
(12.8
)%
 
   Net income margin %
9.4
%
 
11.3
%
 
(1.9
)
pp

(a) Percentage points ("pp").

Net sales - Net sales for year to date September 30, 2018 were $271,239, an increase of 4.6 percent compared to the year-ago period, which was the result of increased net sales in both segments. Within the distillery segment, net sales were up 3.9 percent. Increases in the net sales of distillers feed and related co-products, food grade alcohol, and warehouse services increased over the prior-year period. Net sales of industrial alcohol and premium beverage alcohol products within food grade alcohol both increased. Within the ingredient solutions segment, net sales were up 8.5 percent. This increase was driven by higher net sales across all product categories, with the largest increases in specialty wheat proteins and commodity wheat proteins and starches (see Segment Results).

Gross profit - Gross profit for year to date September 30, 2018 was $57,991, an increase of 2.7 percent compared to the year-ago period. The increase was driven by an increase in gross profit in the ingredient solutions segment, partially offset by a decrease in gross profit in the distillery products segment. In the ingredient solutions segment, gross profit increased by $1,750, or 23.6 percent. In the distillery products segment, gross profit declined by $250, or 0.5 percent (see Segment Results).

SG&A expenses - SG&A expenses for year to date September 30, 2018 were $24,455, an increase of 1.4 percent compared to the year-ago period. The increase in SG&A was primarily due to investments in our brands platform (personnel costs and advertising and promotion), partially offset by a reduction in professional fees and lower personnel costs.


21



Operating income - Operating income for year to date September 30, 2018 increased to $33,536 from $32,377 for the period ended September 30, 2017, due to a gross profit increase in our ingredient solutions segment, partially offset by an increase in SG&A expenses described above and a gross profit decrease in our distillery products segment.
Operating income, year to date versus year to date
 
Operating Income
 
 Change
 
Operating income for year to date ended September 30, 2017
 
$
32,377

 
 
 
Increase in gross profit - ingredient solutions segment(a)
 
1,750

 
5.4

pp(b)
Decrease in gross profit - distillery products segment(a)
 
(250
)
 
(0.8
)
pp
Increase in SG&A expenses
 
(341
)
 
(1.0
)
pp
Operating income for year to date ended September 30, 2018
 
$
33,536

 
3.6
 %
 

(a) See segment discussion.
(b) Percentage points ("pp").

Equity method investment / Gain on sale of equity method investment - We had no equity method investment earnings for year to date September 30, 2018, compared to an equity method investment loss of $348 for the period ended September 30, 2017. The change in equity method investment earnings was due to the sale of our ICP equity method investment on July 3, 2017, which resulted in a gain on sale of equity method investment for the year to date of $11,381 (see Note 3).

Income tax expense - Income tax expense for year to date September 30, 2018 was $7,244, for an effective tax rate of 22.1 percent. Income tax expense for year to date September 30, 2017 was $13,292, for an effective tax rate of 31.3 percent. The significant decrease in income tax expense, year to date versus year to date, was due to the tax impact of the previously-mentioned sale of ICP and the implementation of the Tax Act. The primary reasons for the 9.2 percentage point decline in our effective tax rate, period versus period, are the decrease resulting from implementation of the Tax Act, partially offset by a change in estimate related to the income tax impact of the ICP sale.

EPS - EPS was $1.48 for year to date September 30, 2018 compared to $1.70 for the period ended September 30, 2017. EPS decreased, year to date versus year to date, primarily due to the absence of a gain on sale of equity method investment in the current period, partially offset by the decrease in our effective tax rate previously described and an increase in operating income.
Change in basic and diluted EPS, year to date versus year to date
 
Basic and Diluted EPS
 
Change
 
Basic and diluted EPS for year to date ended September 30, 2017
 
$
1.70

 
 
 
Increase in operations(a)
 
0.05

 
2.9

pp(b)
Decrease in equity method investment loss(a)
 
0.01

 
0.6

pp
Decrease in gain on sale of equity method investment(a)
 
(0.44
)
 
(25.9
)
pp
Tax: Change in effective tax rate
 
0.14

 
8.2

pp
Decrease in income attributable to participating securities
 
0.02

 
1.3

pp
Basic and diluted EPS for year to date ended September 30, 2018
 
$
1.48

 
(12.9
)%
 

(a) 
Items are net of tax based on the effective tax rate for the base year (2017), excluding the effect of the tax benefit on vested share-based compensation on the 2017 rate.
(b) 
Percentage points ("pp").








22



SEGMENT RESULTS

Distillery Products

The following table shows selected financial information for our distillery products segment for quarters ended September 30, 2018 and 2017.
 
PRODUCT GROUP NET SALES
 
 
Quarter Ended September 30,
 
Quarter versus Quarter Net Sales Change Increase / (Decrease)
 
Quarter versus Quarter Volume Increase / (Decrease)
 
 
2018
 
2017
 
$ Change
 
% Change
 
% Change
 
 
 
 
 
 
 
Premium beverage alcohol
$
46,864

 
$
43,941

 
$
2,923

 
6.7
 %
 
 
 
Industrial alcohol
20,661

 
19,310

 
1,351

 
7.0

 
 
 
Food grade alcohol(a)
67,525

 
63,251

 
4,274

 
6.8

 
 
 
Fuel grade alcohol(a)
1,576

 
1,458

 
118

 
8.1

 
 
 
Distillers feed and related co-products
5,898

 
4,860

 
1,038

 
21.4

 
 
 
Warehouse services
3,337

 
2,766

 
571

 
20.6

 
 
 
Total distillery products
$
78,336

 
$
72,335

 
$
6,001

 
8.3
 %
 
7.3
%
(a) 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other Financial Information
 
 
 
 
Quarter Ended September 30,
 
Quarter versus Quarter Increase / (Decrease)
 
 
 
 
2018
 
2017
 
$ Change
 
% Change
 
 
 
 
 
 
 
 
 
 
Gross profit
$
16,269

 
$
16,501

 
$
(232
)
 
(1.4
)%
 
 
 
Gross margin %
20.8
%
 
22.8
%
 


 
(2.0
)
pp(b)
 
 

(a) Volume change for alcohol products.
(b) Percentage points ("pp").

Total net sales of distillery products increased $6,001, or 8.3 percent. Net sales of food grade alcohol, distillers feed and related co-products, and warehouse services increased. Net sales of premium beverage alcohol and industrial alcohol products increased 6.7 percent and 7.0 percent, respectively, compared to the prior-year quarter. The growth in premium beverage alcohol was driven both by volume and a higher average selling price. Industrial alcohol net sales growth was driven by volume as the average selling price was down due to more difficult market conditions. The increase in net sales of distillers feed and related co-products was due to a higher average selling price reflecting improved market conditions during the quarter.
Gross profit decreased slightly quarter versus quarter by $232, or 1.4 percent. Gross margin for the quarter ended September 30, 2018 decreased to 20.8 percent from 22.8 percent for the prior-year quarter. The decline in gross profit was primarily due to higher production costs at the Lawrenceburg facility, lower gross margins and profits on industrial alcohol, partially offset by higher gross profits on premium beverage alcohol (excluding the higher production costs) and distillers feed and related co-products.


23



Distillery Products

The following table shows selected financial information for our distillery products segment for year to date ended September 30, 2018 and 2017.
 
PRODUCT GROUP NET SALES
 
 
Year to Date Ended September 30,
 
Year to Date versus Year to Date Net Sales Change Increase / (Decrease)
 
Year-to-Date versus Year to Date Volume Increase / (Decrease)
 
 
2018
 
2017
 
$ Change
 
% Change
 
% Change
 
 
 
 
 
 
 
Premium beverage alcohol
$
133,135

 
$
131,868

 
$
1,267

 
1.0
 %
 
 
 
Industrial alcohol
59,300

 
57,775

 
1,525

 
2.6

 
 
 
Food grade alcohol(a)
192,435

 
189,643

 
2,792

 
1.5

 
 
 
Fuel grade alcohol(a)
5,006

 
4,867

 
139

 
2.9

 
 
 
Distillers feed and related co-products
18,785

 
14,514

 
4,271

 
29.4

 
 
 
Warehouse services
9,139

 
7,960

 
1,179

 
14.8

 
 
 
Total distillery products
$
225,365

 
$
216,984

 
$
8,381

 
3.9
 %
 
2.7
%
(a) 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other Financial Information
 
 
 
 
Year to Date Ended September 30,
 
Year to Date versus Year to Date Increase / (Decrease)
 
 
 
 
2018
 
2017
 
$ Change
 
% Change
 
 
 
 
 
 
 
 
 
 
Gross profit
$
48,819

 
$
49,069

 
$
(250
)
 
(0.5
)%
 
 
 
Gross margin %
21.7
%
 
22.6
%
 
 
 
(0.9
)
pp(b)
 
 

(a) Volume change for alcohol products.
(b) Percentage points ("pp").

Total net sales of distillery products increased $8,381, or 3.9 percent. Net sales of distillers feed and related co-products, food grade alcohol, and warehouse services increased over the prior-year period. Net sales of industrial alcohol and premium beverage alcohol products within food grade alcohol increased 2.6 percent and 1.0 percent, respectively, compared to the prior-year period. The increase in net sales of distillers feed and related co-products was due to a higher average selling price reflecting improved market conditions during the period.
Gross profit decreased slightly year to date versus year to date by $250, or 0.5 percent. Gross margin for year to date September 30, 2018 decreased to 21.7 percent from 22.6 percent for the prior-year period. The decline in gross profit was primarily due to lower gross margins and profits on industrial alcohol and higher production costs at the Lawrenceburg facility, partially offset by higher gross margins and profits on distillers feed and related co-products and premium beverage alcohol (excluding higher production costs).




24



Ingredient Solutions

The following table shows selected financial information for our ingredient solutions segment for quarters ended September 30, 2018 and 2017.
 
PRODUCT GROUP NET SALES
 
Quarter Ended September 30,
 
Quarter versus Quarter Net Sales Change Increase / (Decrease)
 
Quarter versus Quarter Volume Increase / (Decrease)
 
2018
 
2017
 
$ Change
 
% Change
 
% Change
 
 
 
 
 
Specialty wheat starches
$
7,030

 
$
7,008

 
$
22

 
0.3
%
 


Specialty wheat proteins
5,486

 
4,939

 
547

 
11.1

 


Commodity wheat starches
2,793

 
1,948

 
845

 
43.4

 
 
Commodity wheat proteins
1,386

 
103

 
1,283

 
1,245.6

 
 
Total ingredient solutions
$
16,695

 
$
13,998

 
$
2,697

 
19.3
%
 
16.0
%
 
 
 
 
 
 
 
 
 
 
 
Other Financial Information
 
 
 
Quarter Ended September 30,
 
Quarter versus Quarter Increase / (Decrease)
 
 
 
2018
 
2017
 
$ Change
 
% Change
 
 
 
 
 
 
 
 
Gross profit
3,330

 
$
2,124

 
$
1,206

 
56.8
%
 
 
Gross margin %
20.0
%
 
15.2
%
 


 
4.8

pp(a)
 

(a) Percentage points ("pp").

Total ingredient solutions net sales for quarter ended September 30, 2018 increased by $2,697, or 19.3 percent, compared to the prior-year quarter. This increase was driven by higher net sales across all product categories, with the largest increases in commodity wheat proteins and starches and specialty wheat proteins, quarter versus quarter.
Gross profit increased quarter versus quarter by $1,206, or 56.8 percent. Gross margin for the quarter ended September 30, 2018 increased to 20.0 percent from 15.2 percent for the prior-year quarter. The increase in gross profit was primarily due to higher gross profits on specialty wheat proteins and starches and commodity wheat proteins, partially offset by lower gross profits on commodity wheat starches. Overall gross profit growth was aided by improved plant efficiencies relative to the prior-year quarter.


25



Ingredient Solutions

The following table shows selected financial information for our ingredient solutions segment for year to date ended September 30, 2018 and 2017.
 
PRODUCT GROUP NET SALES
 
Year to Date Ended September 30,
 
Year to Date versus Year to Date Net Sales Change Increase / (Decrease)
 
Year to Date versus Year to Date Volume Increase / (Decrease)
 
2018
 
2017
 
$ Change
 
% Change
 
% Change
 
 
 
 
 
Specialty wheat starches
$
21,170

 
$
20,826

 
$
344

 
1.7
%
 
 
Specialty wheat proteins
16,230

 
14,541

 
1,689

 
11.6

 
 
Commodity wheat starches
6,926

 
6,302

 
624

 
9.9

 
 
Commodity wheat proteins
1,548

 
602

 
946

 
157.1

 
 
Total ingredient solutions
$
45,874

 
$
42,271

 
$
3,603

 
8.5
%
 
1.0
%
 
 
 
 
 
 
 
 
 
 
 
Other Financial Information
 
 
 
Year to Date Ended September 30,
 
Year to Date versus Year to Date Increase / (Decrease)
 
 
 
2018
 
2017
 
$ Change
 
% Change
 
 
 
 
 
 
 
 
Gross profit
$
9,172

 
$
7,422

 
$
1,750

 
23.6
%
 
 
Gross margin %
20.0
%
 
17.6
%
 
 
 
2.4

pp(a)
 

(a) Percentage points ("pp").

Total ingredient solutions net sales for year to date ended September 30, 2018 increased by $3,603, or 8.5 percent, compared to the prior-year period. This increase was driven by higher net sales across all product categories, with the largest increases in specialty wheat proteins and commodity wheat proteins and starches, period versus period.
Gross profit increased period versus period by $1,750, or 23.6 percent. Gross margin for year to date ended September 30, 2018 increased to 20.0 percent from 17.6 percent for the prior-year period. The increase in gross profit was primarily due to higher gross profits on specialty wheat proteins and starches, partially offset by lower gross profits on commodity wheat products. Overall gross profit growth was aided by improved plant efficiencies relative to the prior-year period.







26



CASH FLOW, FINANCIAL CONDITION AND LIQUIDITY

We believe our financial condition continues to be of high quality, as evidenced by our ability to generate adequate cash from operations while having ready access to capital at competitive rates.

Operating cash flow and debt through our Credit Agreement and Note Purchase Agreement (Note 4) provide the primary sources of cash to fund operating needs and capital expenditures. These same sources of cash are used to fund shareholder dividends and other discretionary uses. Going forward, we expect to use cash to implement our invest to grow strategy, particularly in the distillery products segment. Our overall liquidity reflects our strong business results and an effective cash management strategy that takes into account liquidity management, economic factors, and tax considerations. We expect our sources of cash, including our Credit Agreement and Note Purchase Agreement, to be adequate to provide for budgeted capital expenditures and anticipated operating requirements for the foreseeable future.

Cash Flow Summary


 
Year to Date Ended
 
 
 
 
September 30,
2018
 
September 30,
2017
 
Changes, Year to Date versus Year to Date
Cash provided by operating activities:
 
 
 
 
 
 
Net income, after giving effect to adjustments to reconcile net income to net cash provided by operating activities
 
$
37,379

 
$
36,209

 
$
1,170

Receivables, net
 
(15,644
)
 
(11,366
)
 
(4,278
)
Inventory
 
(14,197
)
 
(10,794
)
 
(3,403
)
Prepaid expenses
 
297

 
(824
)
 
1,121

Accrued expenses
 
(2,623
)
 
790

 
(3,413
)
Income taxes payable/refundable
 
(31
)
 
2,472

 
(2,503
)
Accounts payable and accounts payable to affiliate, net
 
(3,453
)
 
844

 
(4,297
)
Other, net
 
(69
)
 
(884
)
 
815

Total
 
$
1,659

 
$
16,447

 
$
(14,788
)
Cash provided by (used in) investing activities: